ESG: Split it in two?
Should ESG be split up into two parts: one focused on risk assessment and another on creating an impact on the world? This is the suggestion in a fascinating article by Stuart Kirk.
Kirk found fame in May when he made some provocative remarks about ESG. As head of responsible investment at HSBC, he told investors that they needn’t worry about climate change as there was always “some nutjob telling me about the end of the world”. He was later suspended from his job.
His new article is more restrained. But it makes an intriguing observation. ESG, he writes, has carried “two meanings from birth”. There is an “input” side where environmental, social and governance issues are assessed as part of a process to judge risk-adjusted returns. But a second approach looks at “outputs”. Here, sustainable or green investments screen out the negative on ethical grounds and seek positive impacts instead. His solution? Acknowledge the difference and split everything into two.
Given all the confusion around ESG at the moment, I find this distinction helpful. Many working in finance think ESG is (mostly) about the former whilst those ordinary (retail) investors interested in this actually want the ‘making a difference’ side.
But I’m not sure this distinction has existed “since birth” like Kirk says. After all, what used to be called “socially responsible investing” has existed for decades. Although a niche, some funds have been seeking to change the world long before E, S & G was coined as a term. The ‘new’ aspect is the massive flows of capital categorised on the ‘input’ side, where assessing ESG has become foundational.
And it’s not quite as simple as two camps. Both types are linked. After all, isn’t negative screening on ethical grounds an ‘input’ to a process, not as output like Kirk says? What about positive screening for best in class – is that an input (process) or output (seeking impact)? It’s both. Crucially, where does the rising tide of engagement to try to change the behaviours of a company fall? It’s a process, on a journey, towards an output.
As with so much of ESG at the moment, Kirk’s two categories just seem too binary to me. After all, those interested in trying to do good with their money probably expect fund managers to screen for risks and seek out the positives.
There is no doubt that more clarity is needed in the industry. There is simply too much confusion – and much poor practice greenwashing – going on right now. A change is likely to be spurred by regulation. The EU’s upcoming Sustainable Finance Disclosure Regulations are seeking to codify exactly these types of distinction. Whilst a split seems too simple, how we define and categorise ESG looks set to change.